Neuroscience in Trading
Through years of experience, I have concluded that in all life’s endeavours, framing the mind properly and preparing for every possible outcome is absolutely essential. If you’re about to start a career as a bodybuilder, it’s crucial to understand both the physical and psychological demands of the journey. Likewise, if you’re training to become a police officer, you need to grasp the challenges of the role and the approach necessary to succeed. In parallel, if you’re advancing as a trader – whether you’re just beginning or building on existing skills – you must cultivate and sustain a state of zen, a quality that every successful trader should embody. Hence, today, we are going to talk about neuroscience in trading.
The question, then, is: what’s the best way to achieve the so-called state of zen? My answer is that, to frame the mind effectively, we must first understand it. The fundamental step, therefore, is to delve into the basics of neuroscience and to explore how different elements of our brain interact while we’re “in the state of trading”. By this, we mean the complete trading experience: learning, experiencing emotions during entry and exit points, exercising patience, and the discipline of “sitting on our hands”.
Various Branches that Play a Role
The animated illustration below portrays what parts of the brain are most prominently in functionality while we are in the state of trading.
Now, let’s dive into them one-by-one and talk about neuroscience in trading.
- Amygdala
The amygdala is critical in processing emotions, particularly fear and greed, which are often heightened during trading. It helps assess risk by triggering emotional responses to perceived dangers or opportunities. In trading, the amygdala may activate in response to sudden market drops (triggering fear) or sharp rises (triggering greed), influencing decisions that may bypass rational thought. - Basal Ganglia
The basal ganglia play a role in habit formation and the recognition of patterns. This region becomes particularly active in experienced traders who have internalised certain market patterns or strategies. Over time, traders develop instincts or “gut feelings” about the market based on repetitive exposure to similar conditions, which may stem from the basal ganglia’s involvement in learned behavior and motor control. - Prefrontal Cortex
The PFC is responsible for higher-order cognitive functions like rational decision-making, impulse control, and strategic planning. It moderates the emotional impulses from the amygdala, helping traders avoid rash decisions based on fear or greed. Experienced traders typically have stronger PFC activation, enabling them to follow a disciplined approach, stick to their strategies, and manage risk without succumbing to emotional biases. - Insula
The insula processes negative emotions and bodily sensations associated with risk and loss, such as discomfort, anxiety, or even physical pain from financial loss. It contributes to loss aversion, a phenomenon where traders feel the pain of losses more intensely than the pleasure of gains, potentially leading to irrational risk-averse behavior (e.g., exiting a profitable trade too early). - Neurotransmitters
Among neurotransmitters, the most distinguished ones would be dopamine, serotonin, and cortisol.
As such, dopamine drives traders to seek rewards (profits), influences risk-taking behaviour, and can lead to addictive behaviours like overtrading. Dopamine levels spike when anticipating or experiencing a win, reinforcing behaviours that may increase risk.
Serotonin regulates mood, social behavior, and emotional stability. It’s involved in maintaining a balanced emotional state, influencing how we process rewards and losses.
Cortisol is the primary stress hormone, released during times of anxiety or pressure. It’s part of the fight-or-flight response, preparing the body to react to threats.
Acknowledging and Benefiting
After understanding these neurobiological elements, we can use them to guide our actions toward a positive outcome. An effective frame of mind is vital for success in financial markets.
To regulate the amygdala (fear and greed) and insula (discomfort), it’s crucial to grasp the psychological aspects of trading. You must understand the importance of the long-term view, accept the inevitability of losses, and practice emotional detachment from trades. Patience and sound risk management principles are essential.
Acknowledging that long-term success is only possible through an effective risk management plan will ease fear. Greed can be managed by setting pre-defined targets and, again, sticking to the risk management plan.
The basal ganglia play a huge role in developing patience, building experience, and fostering persistence. As you enhance your skills in the market, these processes become second nature, contributing to long-term profitability.
The prefrontal cortex works best when free from distractions and overstimulation. To maintain focus and mindfulness, which are critical for rational decision-making, you must clear your mind of unnecessary thoughts.
Neurotransmitters can be regulated using these same principles. Remember, trading is not a form of gambling. If your trading feels boring, you’re likely on the right path. Sitting on your hands 80% of the time is difficult, but this patience separates winners from those who struggle.
In short, focus on the long-term picture and detach emotionally from individual trades. Dedicate your attention to sustained success over time.
Conclusion – Refraining from Radicalisation
In trading, we often say that the more minimalistic and simple the approach, the better it is overall. When a big move occurs in the market, instead of overanalysing every small detail, I detach and refrain from questioning it. Every move happens for a reason. What we see on the graph – price development and behaviour – reflects the premeditation of what will happen next. In other words, “it happened because it had to happen” is a better mindset than constantly asking, “Why did this happen?”
The same principle applies to the topic we’re discussing here. Understanding neuroscience in trading is interesting and informative. But not every mechanism needs to be questioned or dissected when things go right or wrong. For example, if you feel anger or frustration after a loss, don’t blame yourself or your brain for reacting that way. Instead, understand your brain’s impulses and work toward correcting the errors.
Ultimately, while it’s not a necessity, comprehending how the brain operates is a valuable tool. It helps us make more rational and constructive decisions for the future.
